Equities look to the IMF for hope

The run-up to the latest EU-summit went through a familiar cycle: hopes and upbeat rumours pumped up equity markets which slumped heavily following the realisation that there is no one solve-all solution to the European debt mess.

As the much-taunted “bazooka” response turned out to be a mere water pistol, prospects for equity markets in the coming week remain difficult to assess. Markets want a response on a massive scale which the Europeans just can’t deliver.

In this respect, the prize for the biggest disappointment of the week goes to the European Central Bank as M. Draghi reaffirmed that he will strictly stick to the role of lender of last resort to European financial institutions. Sovereign rescues remain out of the ECB’s legal boundaries.

On the positive side, a fiscal compact was agreed and a relatively swift implementation, at least by technocrats’ standards, could be expected. Europeans in essence are saying that in the future, they promise to exercise more control over their spending.

Yet this does not solve the issue of the mess that has been created by past mismanagement. In short the stock of debt remains and the wall of required refinancing is still looming.

Indeed as can be seen in the case of too-big-to-save Italy, there is roughly EUR 140 billion worth of refinancing to be done between February and April 2012:

Source: Bloomberg and Saxo Bank Strategy Team

This is the real challenge in a context of European financial institutions desperate to deleverage massively and raise fresh capital themselves in order to meet current shortfalls.

Hence the odds for an intervention of the International Monetary Fund in the crisis are sharpening rapidly. European governments will pay their share to the IMF for the upcoming rescue to the tune of some EUR 200 billion and will be waiting eagerly for other countries to join.

This should be one of the most significant developments to watch out for next week. Any hint that the IMF is being armed to act on a massive scale in the crisis when (and not if!) it will be needed would be the signal that markets have been waiting for. Watch out for announcements over the weekend!

From a trading perspective, we can only say that markets remain as treacherous as ever. Trading zones are however clear. Indeed, for DAX we have re-entered the consolidation the 6,000-5,800 area.

DAX cash index – Daily chart – source: Bloomberg

In fact, the zone was traded in a single day today from top to bottom and down again! This is the most likely range for trading next week, bar any game-changing announcement over the weekend.

Above the 6,200 mark, we would exercise great caution as prospects for European equity markets past the January effect period look dire.

For the US and at the risk of repeating ourselves, the positive momentum in the economic news keeps rolling but the European situation has kept a lid on the market.

With a relatively better fundamental background, the S&P 500 still looks ready to head back towards the 1,300 mark.

S&P 500 cash index – Daily chart – source: Bloomberg

After a triple rejection of the 200-day moving average and a big knee-jerk reaction due to developments on our shores, the index looks somehow vulnerable.

Still, should we manage to hang around the 1,250 mark by the close of this week we should expect another challenge higher next week. Strong support should be found around 1,220 for the current move.